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Wednesday,
December 12, 2018 13.58PM / By US SEC
Testimony On “Oversight Of The U.S. Securities And Exchange Commission”
By SEC Chairman Jay Clayton - Before The U.S. Senate Committee On Banking,
Housing, And Urban Affairs
Chairman
Crapo, Ranking Member Brown and Senators of the Committee, thank you for the
opportunity to testify before you today about the work of the U.S. Securities
and Exchange Commission (SEC or Commission or Agency).[1]
Chairing
the Commission is a great privilege, and I am fortunate to be able to observe
firsthand the incredible work done by the agency’s almost 4,500 dedicated
staff, approximately41 percent of whom are outside of Washington, D.C., in our
eleven regional offices.
Our
people are our greatest assets, and they are our direct connection to the
investors we serve. None of the important work described in this
testimony would have been achieved without the solutions-oriented attorneys,
accountants, examiners and economists at the SEC, whose work, in turn, is made
possible thanks to the important, often behind-the-scenes work of the agency’s
administrative and operations personnel. The agency’s supervisors
and program managers also play a critical role in ensuring effective and
efficient operations and activities.
Across
the SEC, we recognize the importance of our capital markets to the U.S. economy
and millions of diverse American households. Our people are skilled and
committed. They accomplish a great deal with the resources at their
disposal, and they are proud to serve. This testimony embodies the
record of their work over the past year in pursuit of the SEC’s tripartite
mission of protecting investors, maintaining fair, orderly and efficient markets
and facilitating capital formation.
New Strategic Plan
We
recently released our Strategic Plan for 2018-2022, which outlines three goals
that will guide the work of the SEC moving forward.[2] I
hope you will agree that we have made meaningful progress over the past year
toward satisfying these goals.
Our
first goal, which has been a priority of mine since I became Chairman, is
focusing on the interests of our long-term Main Street
investors. The past year has presented many opportunities for me, my
fellow Commissioners and SEC staff to interact directly with investors from
across the country. Those discussions allowed us to better answer
the question we ask ourselves every day: how does our work benefit
the Main Street investor? Each proposal or action we take is guided
by that principle.
Our
second goal—to be innovative and responsive—reflects the changing nature of our
markets. As technological advancements and commercial developments
have changed how our securities markets operate, the SEC’s ability to remain an
effective regulator requires that we continually monitor the market environment
and adapt our rules, regulations and oversight. This maxim applies
to nearly every facet of what we do at the SEC. For example, it
drove the establishment of a Cyber Unit in the Division of Enforcement
(Enforcement or Division) in September 2017, a Fixed Income Market Structure
Advisory Committee in November 2017, and more recently, our new Strategic Hub
for Innovation and Financial Technology (FinHub).
Our
third goal—elevating the agency’s performance through technology, data
analytics and human capital—embodies our commitment to maintaining an effective
and efficient operation. We are using technology, analyzing data and
promoting information-sharing and collaboration across the agency, while also
maintaining the work environment that has resulted in consistent high levels of
employee satisfaction. Maintaining a high level of staff engagement,
performance and morale is critical to our ability to execute the SEC’s
mission. We are committed to continued investment in both new
technology and human capital.
The Commission’s Fiscal Year 2018 Initiatives and Upcoming Agenda
I am
proud of what our people have accomplished in Fiscal Year (FY) 2018 and look
forward to building on this work as we continually review and recalibrate our
approach to accomplishing the SEC’s mission. Overall, America’s
historic approach to our capital markets has produced a remarkably deep pool of
capital with unprecedented participation. It is our Main Street investors
and their willingness to commit their hard-earned money to our capital markets
for the long term that have ensured that the U.S. capital markets have long
been the deepest, most dynamic and most liquid in the world. Their
capital provides businesses with the opportunity to grow and create jobs, and
supplies the capital markets with the funds that give the U.S. economy a
competitive advantage. In turn, our markets have provided American
Main Street investors with better investment opportunities than comparable
investors in other jurisdictions.
To
place this historic achievement in perspective, I note that the United States
has approximately 4.4 percent of the world’s population, yet the U.S. markets
are the primary home to 56 of the world’s 100 largest publicly traded
companies, and U.S. households have over $22.4 trillion invested in the world’s
equity markets.[3]
More
significantly, at least 52 percent of U.S. households are invested directly or
indirectly in our capital markets.[4]
This level of retail investor participation stands out against other large
industrialized countries and is especially important to keep in mind as our
Main Street investors—whether they participate in our markets directly or
through an intermediary such as an investment adviser or broker-dealer—now,
more than ever, have a substantial responsibility to fund their own retirement
and other financial needs. As a result of increased life expectancy and a
shift from defined benefit plans (e.g., pensions) to defined contribution plans
(e.g., 401(k)s and IRAs), the interests and needs of our Main Street investors
have changed.
We are
responding to that change. It is our obligation to preserve, foster
and build on the successful history of our capital markets, and history and
experience demonstrate our work is never complete. Markets change,
and new risks to our markets and investors will emerge. We know we
must continuously assess whether we are focused on the right areas and doing
the right things, keeping the interests of our long-term Main Street investors
top of mind.
My
testimony summarizes our important FY 2018 initiatives, grouping them in five
areas: (1) the regulatory and policy agenda; (2) enforcement and
compliance; (3) enterprise risk and cybersecurity; (4) increasing our
engagement with investors and other market participants; and (5) emerging
market risks and trends. It also discussesa number of
forward-looking initiatives that we are pursuing as our 2019 near-term agenda
is now publicly available.[5] Continuing
with the themes of transparency, accountability and clarity of mission, the
2019 near-term agenda focuses on the initiatives we reasonably expect to
complete over the next 12 months. I welcome feedback from all
interested parties on areas in need of focus and how we can best allocate our
resources.
Regulatory and Policy Agenda
During
my September 2017 testimony, I noted that the near-term Regulatory Flexibility
Act agenda would be streamlined to increase transparency and accountability to
the public and Congress, as well as to provide greater clarity to our
staff. The 2017 agenda embodied a collective effort, benefiting from the
input of my fellow Commissioners, our division and office heads and many
members of our staff on key questions, including: (1) what
initiatives the agency could reasonably expect to complete over the next 12
months, and (2) of those initiatives, which ones would have the most positive
impact on our Main Street investors.
During
the last year, the Commission advanced 23 of the 26 rules in the near-term
agenda, a good result on both a percentage basis (88 percent) and an absolute
basis.[6]
In
addition, the Commission responded to major events and changes in the broader
regulatory landscape by advancing several other initiatives not in the original
agenda. For example, we issued guidance to public companies about
disclosures of cybersecurity risks and incidents.[7] During
FY 2018, the Commission also responded to a new congressional mandate from the
Economic Growth, Regulatory Relief, and Consumer Protect Act by expanding a key
registration exemption used by non-reporting companies to issue securities
pursuant to compensatory arrangements,[8]and
provided relief for those affected by Hurricane Florence.[9] In
addition, to facilitate more accurate, clear and timely communications between
issuers and shareholders, the staff released guidance on how to approach
near-term financial reporting uncertainties resulting from tax law changes on
the same day the bill was signed by the President.[10]
To be
sure, statistics—such as an 88 percent completion rate—often fail to tell more
than a narrow story. Main Street investors—the market participants
we have at the front of our minds—will not assess our work by the number or
percentage of rules and initiatives we complete, but rather will be looking at
what our efforts substantively do for them. With this metric—the interests
of our long-term Main Street investors—in mind, I will discuss in more detail a
few examples of our work in 2018.
Standards of Conduct Proposals
In
April 2018, the Commission proposed for public comment a significant rulemaking
package designed to serve Main Street investors that would: (1) require
broker-dealers to act in the best interest of their retail customers; (2)
reaffirm, and in some cases clarify, the fiduciary duty owed by investment
advisers to their clients; and (3) require both broker-dealers and investment
advisers to state clearly key facts about their relationship, including their
financial incentives.[11] This
package of rulemakings is intended to enhance investor protection by applying
fiduciary principles across the spectrum of investment advice, bringing the
legal requirements and mandated disclosures of financial professionals in line
with investor expectations.
Broker-dealers
and investment advisers both provide investment advice to retail investors, but
their relationships are structured differently and are subject to different
regulatory regimes. However, it has long been recognized that many
investors do not have a firm grasp of the important differences between
broker-dealers and investment advisers—from differences in the types of
services that they offer and how investors pay for those services, to the
regulatory frameworks that govern their relationships. This
confusion could cause investor harm if, for example, investors fail to select
the type of service that is appropriate for their needs or if conflicts of
interest are not adequately understood and addressed. Our proposals
would work together to better align the standards of conduct and mandated
disclosures for both broker-dealers and investment advisers with what investors
expect of these financial professionals, while preserving investor access and
investor choice.
Specifically,
proposed Regulation Best Interest would enhance broker-dealer standards of
conduct by establishing an overarching obligation requiring broker-dealers to
act in the best interests of the retail customer when making recommendations of
any securities transaction or investment strategy involving
securities. Simply put, under proposed Regulation Best Interest, a
broker-dealer cannot put her or his interests ahead of the retail customer’s
interests. The proposal incorporates that key principle and goes
beyond and enhances existing suitability obligations under the federal
securities laws. To meet this requirement, the broker-dealer would
have to satisfy disclosure, care and conflict of interest
obligations.
Among
other things, the obligations under proposed Regulation Best Interest would put
greater emphasis on costs and financial incentives as factors in evaluating the
facts and circumstances of a recommendation. Additionally, the
proposed standard would require broker-dealers to establish, maintain and
enforce written policies and procedures reasonably designed to identify and
eliminate material conflicts of interest, or disclose and mitigate, material
conflicts of interest related to financial incentives. This is a
significant and critical enhancement as today the federal securities laws
largely center on conflict disclosure rather than conflict management.
Proposed
Regulation Best Interest and its “best interest” standard draw upon fiduciary
principles in other contexts, including those underlying an investment
adviser’s fiduciary duty,recognizing that while their relationship models
differ, both broker-dealers and investment advisers often provide advice in the
face of conflicts of interest. These common principles are easier to
compare given that we issued as another part of our reform package a proposed
interpretation reaffirming—and, in some cases, clarifying—the fiduciary duty
that investment advisers owe to their clients. This interpretation
is designed to provide advisers and their clients with a reference point for
understanding the obligations of investment advisers to their clients and,
specifically, reaffirms that an investment adviser also must act in the best
interests of her or his client.
While
the two standards are based on common principles, under the proposal, some
obligations of broker-dealers and investment advisers will differ because the
relationship models of these financial professionals
differ. But—importantly—the principles are the same, and I believe
the outcomes under both models should be the same: retail investors
receive advice provided with diligence and care that does not put the financial
professional’s interests ahead of the investor’s interests. I
believe our proposals are designed to make investors get just that whether they
choose a broker-dealer or an investment adviser.
In
order to hear first-hand from retail investors who will be directly impacted by
the rulemaking package, the staff organized seven roundtables across the
country to provide Main Street investors the opportunity to speak directly with
me, my fellow Commissioners and senior SEC staff to tell us about their
experiences and views on what they expect from their financial
professionals. I had the opportunity to lead five of these
discussions—in Houston, Atlanta, Miami, Denver and Baltimore—and attend another
in Washington, D.C. The sec and id, experience-based conversations
were incredibly valuable and are informing our work moving
forward. The transcripts from these roundtables are included in our
public comment file. We also have invited investors to view samples
of the proposed disclosure form to share their insights and feedback with the
Commission by going to https://www.sec.gov/tell-us. In
addition, our Office of the Investor Advocate engaged RAND Corporation to
perform investor testing of the proposed disclosure form. The
results of the investor testing are available on the SEC’s website in order to
allow the public to consider and comment on this supplemental information.[12]
The
staff of the Division of Trading and Markets and the Division of Investment Management
are reviewing all of this information, and the more than 6,000 comment
letters,[13]as
they work diligently together to develop final rule recommendations.
Facilitating
Capital Formation
The
SEC took meaningful steps during FY 2018 to encourage capital formation for
emerging companies seeking to enter our public capital markets while
maintaining, and, in many cases, enhancing investor
protections. Doing so provides greater investment opportunities for
Main Street investors, as it is generally difficult and expensive for them
to invest in private companies. As a result, Main Street investors
may not have the opportunity to participate in the growth phase of these
companies if they choose not to enter our public markets or do so only later in
their life cycle. Additionally, it is my experience that companies
that go through the SEC public registration and offering process often come out
as better companies, providing net benefits to the company, investors and our
capital markets.
As a
result of the July 2017 expansion of the draft registration statement
submission process to all first-time registrants and newly public companies
conducting initial public offerings (IPOs) and offerings within one year of an
IPO, the Division of Corporation Finance (Corporation Finance) has received
draft submissions for more than 40 IPOs and from more than 75 existing
reporting companies that have utilized the expanded
accommodation. This change has given companies more control over
their offering schedules and has limited their exposure to market volatility
and competitive harm—providing a benefit to their shareholders without
diminishing investor protection.
Additionally,
in June 2018, the Commission voted to adopt amendments to the “smaller
reporting company” definition that expand the number of companies that can
qualify for certain existing scaled disclosure requirements.[14] The
new definition recognizes that a one-size regulatory structure for public
companies does not fit all and will allow approximately 1,000 additional
companies to benefit from smaller reporting company status. The
amended definition should benefit both smaller companies, by making the option
to join our public markets more attractive, and Main Street investors, who, in
turn, will have more investment options.
The
Commission also has taken steps to simplify and update financial
disclosures. In July 2018, we proposed amendments to financial
disclosures to encourage guaranteed debt offerings to be conducted on a
registered rather than a private basis.[15] I
believe these measures have the potential to save issuers significant time and
expense, enhance the quality of disclosure and increase investor protection.
Further,
in August 2018, the Commission adopted final rules that simplify and update
disclosures by eliminating requirements that are outdated, overlapping or
duplicative of other Commission rules or U.S. GAAP.[16] These
amendments were part of a larger initiative by Corporation Finance to review
disclosure requirements applicable to issuers and consider ways to improve the
requirements for the benefit of investors and issuers. While these
rule changes may appear technical, I anticipate that they will yield
substantial benefits for public companies and investors, especially when taken
together with other capital formation initiatives at the
Commission. Importantly, they will not adversely affect the
availability of material information and, in many cases, will enhance the
quality of available information and increase investor protection.
Corporation
Finance has several proposals on the horizon designed to encourage capital
formation for emerging companies seeking to enter our public capital
markets. Specifically, I anticipate the Commission will consider a
proposal to amend the definition of “accelerated filer” that triggers Section
404(b) of the Sarbanes-Oxley Act of 2002, which requires registrants to provide
an auditor attestation report on internal control over financial reporting,
that if adopted will have the effect of reducing the number of companies that
need to provide the auditor attestation report, while maintaining appropriate
investor protections.[17] While
Section 404(b) has become a familiar, and in many cases important, component of
our public company regulatory regime, we have heard from market participants
and our former Advisory Committee for Small and Emerging Companies that,
particularly for smaller companies, the costs associated with this requirement
can divert significant capital from the core business needs of companies
without a corresponding investor benefit. I look forward to
considering the staff’s recommendations.
Additionally,
I anticipate that the Commission will consider expanding the ability of
companies that are contemplating raising capital to “test-the-waters” by
engaging in communications with certain potential investors prior to or
following the filing of a registration statement for an IPO. I have
seen firsthand how this has benefitted companies considering an IPO, as they
are able to engage investors earlier to explain their business and obtain
feedback in advance of an offering. This also benefits investors and
shareholders as companies are better able to determine the appropriate time for
an offering and to more effectively size and price the offering. I
look forward to the Commission considering this initiative in the coming
year.
Further,
I expect that the Commission will consider a proposal, as required by the
Economic Growth, Regulatory Relief, and Consumer Protection Act, to expand
Regulation A offering eligibility to public reporting companies.
Finally,
I believe it is important to encourage long-term investment in our
country. I expect that the Commission will soon consider a release
soliciting input on how we can reduce compliance burdens on reporting companies
with respect to quarterly reports while maintaining, and in some cases
enhancing, investor protections. There is an ongoing debate regarding
our approach to mandated quarterly reporting and the prevalence of optional
quarterly guidance, and whether our reporting system more generally drives an
overly short-term focus. I encourage all market participants to
share their views and to let us know if there are other aspects of our
regulations that drive short-termism inappropriately.
Beyond
our public markets, I anticipate the Commission will take a fresh look at the
exempt offering framework to consider whether changes should be made to harmonize
and streamline the framework. Congress and the SEC have taken a
number of steps to expand the options that small businesses have to raise
capital. Small businesses today have more options to reach investors
within their state using the intrastate exemption, or tap the “crowd” using the
power of the Internet through Regulation Crowdfunding offerings. Small
businesses can decide to limit their offerings to sophisticated investors in
reliance on Regulation D, or open those offerings to retail investors using
Regulation A.[18]
Additionally,
pursuant to the Economic Growth, Regulatory Relief, and Consumer Protection
Act, the SEC recently expanded the exemption that permits private companies to
issue securities to employees, consultants and advisors as compensatory
awards—a transaction that preserves cash for the company’s operations and
aligns the incentives of employees with the success of the company—and
solicited comment on further ways to modernize the rules related to these
compensatory arrangements.[19] The
so-called “gig economy” has changed how companies and individuals design
alternative work arrangements, and, therefore, individuals may not be
“employees” eligible to receive securities as compensatory awards under our
current exemption.
While
the options to raise capital in exempt offerings have grown significantly since
the JOBS Act, there has not been a comprehensive review of our exemptive
framework to ensure that the system, as a whole, is rational, accessible, and
effective. In fact, I doubt anyone would have come up with anything
close to the complex system we have today if they were starting with a blank
slate. So, I believe we should take a critical look at our exemption
landscape, which can be fairly described as an elaborate patchwork.[20] The
staff is working on a concept release that I expect will bring to the forefront
these and other topics on how we can harmonize exempt
offerings. Receiving input from investors, startups, entrepreneurs
and other market participants who have first-hand experience with our framework
is extremely important to make sure we get it right.
Improving
the Proxy Process
Another
significant initiative for 2019 is improving the proxy process. Last
month, the SEC staff held a proxy roundtable to discuss: (1) the
proxy solicitation and voting process; (2) shareholder engagement through the
shareholder proposal process; and (3) the role of proxy advisory firms.[21] I
was pleased with this solutions-oriented event, which included a diverse group
of panelists representing the views of investors, companies and other market
participants. While we heard a wide range of views, we saw more
agreement than disagreement, and I believe that we should act to improve each
of these areas.
There
was consensus among the panelists that the proxy “plumbing” needs a major
overhaul. I encourage market participants to explore what such an
overhaul would entail and to consider how technology, including distributed
ledger technology, could improve the proxy plumbing. I realize a
major overhaul could take time. So, I believe we should focus on
what the Commission can do in the interim to improve the current
system. The comment box for the roundtable remains open, and I
encourage all those interested in improving the proxy plumbing to share their
thoughts, particularly regarding actionable, interim improvements.
I also
believe it is clear that we should consider reviewing the ownership and
resubmission thresholds and related criteria for shareholder
proposals. The current $2,000 ownership threshold and related
criteria were adopted 20 years ago in 1998, and the resubmission thresholds
have been in place since 1954. A lot has changed since
then. We need to be mindful of these changes, and make sure our
approach to the very important issue of shareholder engagement reflects the
realities of today’s markets and today’s investors. As I have said
before, when looking at the ownership and resubmission thresholds and related
criteria, we need to consider the interests of the long-term retail investors
who invest directly in public companies and indirectly through mutual funds,
ETFs and other products. With these long-term, retail investors in
mind, we also should consider whether there are factors, in addition to the
amount invested and the length of time shares are held, that reasonably
demonstrate that the proposing shareholder’s interests are aligned with those
of a company’s long-term investors.
For
proxy advisory firms, I believe there is growing agreement that the current
dynamics among four parties, (1) proxy advisory firms, (2) investment advisers
who employ those firms and have a fiduciary duty to their investors, (3)
issuers and (4) investors at large, including our Main Street investors, can be
improved. For example, there should be greater clarity regarding the
division of labor, responsibility and authority between proxy advisors and the
investment advisers they serve. We also need clarity regarding the
analytical and decision-making processes advisers employ, including the extent
to which those analytics are company or industry specific. On this
last point, it is clear to me that some matters put to a shareholder vote can
only be analyzed effectively on a company-specific basis, as opposed to
applying a more general market or industry-wide policy.
Finally,
there were other issues raised at the roundtable that we should consider,
including: (1) the framework for addressing conflicts of interests
at proxy advisory firms, and (2) ensuring that investors have effective access
to issuer responses to information in certain reports from proxy advisory
firms.
The
staff is looking at these and other issues, and I have asked them to formulate recommendations
for the Commission’s consideration. On timing, it is clear to me
that these issues will not improve on their own with time, and I intend to move
forward with the staff recommendations, prioritizing those initiatives that are
most likely to improve the proxy process and our markets for our long-term Main
Street investors.
Modernizing
Trading and Market Structure
Another
area of focus for the Commission is ensuring fair and efficient trading markets
for our Main Street investors. We know that transparency is a
bedrock of healthy and vibrant markets, and I am pleased to report that we have
taken significant steps to make our trading markets more
transparent.
In
July 2018, we adopted amendments that enhance the transparency requirements governing
alternative trading systems, commonly known as “ATSs.”[22] These
amendments provide investors, brokers and other market participants—and the
Commission—with increased visibility into the operations of these important
markets for equity trading. Additionally, last month, the Commission
adopted amendments to Regulation NMS to provide investors with greater transparency
concerning how brokers handle and execute their orders.[23]
Further,
in March 2018, the Commission proposed a transaction fee pilot for National
Market System (NMS) stocks, which, if adopted, would provide the
Commission with data to help us analyze the effects of exchange fees and
rebates on order routing behavior, execution quality and our market structure
generally.[24]
This topic has received significant attention ever since the implementation of
Regulation NMS. More recently, the development of a pilot program on
transaction fees was one of the SEC’s Equity Market Structure Advisory
Committee’s most prominent recommendations to the Commission.[25] In
my view, the proposed pilot—which I expect the Commission to consider for
adoption in the near future—would lead to a more thorough understanding of
these issues, which would help the Commission make more informed and effective
policy decisions in the future, all to the benefit of retail investors.
Our
fixed income markets are also critical to our economy and Main Street
investors, though historically, less attention has been focused on these
relative to the equity markets. With large numbers of Americans
retiring every month and needing investment options, fixed income products
attract more and more Main Street investors. Yet, many of those
investors may not appreciate that fixed income products are part of markets
that differ significantly from the equity markets.
In
November 2017, the SEC created the Fixed Income Market Structure Advisory
Committee (FIMSAC) to provide diverse perspectives on the structure and
operations of the U.S. fixed income markets, as well as advice and
recommendations on fixed income market structure. The Committee has
held four public meetings and has provided the Commission with five thoughtful
recommendations on ways to improve our fixed income markets.[26] I
look forward to an equally successful second year.
Finally,
new FINRA and MSRB requirements regarding the disclosure of corporate and
municipal bond mark-ups and mark-downs went into effect, and I am pleased that
investors now have substantially greater transparency into the costs of
participating in those markets. I believe this transparency will
increase competition and reduce trading costs, all to the benefit of Main
Street investors.
Consolidated
Audit Trail
Another
market structure initiative that is garnering significant staff attention is
the implementation of the Consolidated Audit Trail (CAT). The CAT is
designed to provide a single, comprehensive database that, when fully implemented,
will allow regulators to more efficiently and accurately track trading in
equities and options throughout the U.S. markets. Among other
things, the CAT is intended to allow the Commission to better carry out its
oversight responsibility by improving our ability to reconstruct trading
activity following a market disruption or other event, which in turn would
allow us to more quickly understand the causes of such an event and respond
appropriately.
Under
the CAT NMS Plan, the self-regulatory organizations (SROs)—the national
securities exchanges and FINRA—are responsible for developing and implementing
the CAT and were required to begin reporting data to the CAT by November 15,
2017. The SROs missed that deadline. While the CAT has
now begun receiving equity and options data with limited functionality, the
SROs remain out of compliance with the CAT NMS Plan today.
The
SROs are making some progress, but the development and implementation process
remains slow and cumbersome due largely to what I believe are project
governance and project management issues experienced by the
SROs. While, pursuant to SEC staff requests, the SROs recently set
forth a revised timeline with detailed milestones, more recently The sys
(the plan processor) informed the SROs that it does not plan to deliver full
functionality of CAT’s first phase in accordance with these
milestones. The SROs have reported to our staff that they currently
expect to deliver the first phase of CAT (which, again, was required to be
delivered by November 15, 2017) by March 31, 2019. We remain
frustrated with failure of the SROs to meet their obligations and the delays in
the development of the CAT.
I know
there are substantial concerns about the protection of investors’ personally
identifiable information (PII) that would be stored in the CAT. I have
the same concerns and continue to make the protection of CAT data, particularly
any form of PII, a threshold issue. In November 2017, I asked the
Commission staff to evaluate the need for PII in the CAT. This evaluation
includes consideration of, among other things, what PII data elements need to
be collected and retained in the CAT in order to achieve the regulatory goals
of the CAT, and how PII in the CAT would be used by the SEC and the SROs. We
are considering what alternatives to the scope of PII that would be collected
and retained by the CAT under the current plan could provide the Commission and
the SROs with the market surveillance and reconstruction data necessary to conduct
our regulatory and enforcement functions.
As I
have stated before, as the SROs continue to make progress in the development,
implementation and operation of the CAT, I believe that the Commission, the
SROs and the plan processor must continuously evaluate their approach to the
collection, retention and protection of PII and other sensitive
data. More generally, I have made it clear that the SEC will not
retrieve sensitive information from the CAT unless we have a regulatory need
for the information and believe appropriate protections to safeguard the
information are in place.
Distributed
Ledger Technology, Digital Assets and Initial Coin Offerings
The
Commission and its staff have been focusing a significant amount of attention
and resources on digital assets and initial coin offerings (ICOs). I
am optimistic that developments in distributed ledger technology can help
facilitate capital formation, providing promising investment opportunities for
both institutional and Main Street Investors. Overall, I believe we
have taken a balanced regulatory approach that both fosters innovation and
protects investors. For example, our staff meets regularly with
entrepreneurs and market professionals interested in developing new and
innovative investment products in compliance with the federal securities laws. Recently,
Corporation Finance’s Director, Bill Hinman, outlined factors for participants
to consider when evaluating whether a digital asset is a security[27]
and also named a new Associate Director in Corporation Finance to serve as the
Senior Advisor for Digital Assets and Innovation and coordinate efforts in this
area across the agency.[28] SEC
staff is also meeting regularly with staff from other regulatory agencies to
coordinate efforts and identify any areas where additional regulatory oversight
may be needed. Divisions and offices across the Commission have
worked together, as well as with other regulators, to issue public statements
regarding ICOs and virtual currencies.[29]
In an
effort to further coordinate the Commission’s work on these important issues,
in October of this year the SEC announced the formation of a FinHub within the
agency.[30] Staffed
by representatives from across the Commission, the FinHub will serve as a
public resource for fintech-related issues at the SEC, including matters
dealing with distributed ledger technology, automated investment advice,
digital marketplace financing and artificial intelligence/machine
learning. In addition to serving as a portal for public engagement,
FinHub will also serve as an internal resource within the SEC, coordinating the
agency staff’s work on these and other fintech-related issues. As
the work of FinHub and our other activities demonstrate, the agency is focused
on issues presented by new technologies, and our door remains open to those
who seek to innovate and raise capital in accordance with the law.
Unfortunately,
while some market participants have engaged with our staff constructively and
in good faith with questions about the application of our federal securities
laws, others have sought to prey on investors’ excitement about
cryptocurrencies and ICOs to commit fraud or other violations of the federal
securities laws. Enforcement has recently brought a number of
landmark cases in this area, and I have asked the Division’s leadership to
continue to police these markets vigorously and recommend enforcement actions
against those who conduct ICOs or engage in other actions relating to digital
assets in violation of the federal securities laws.
The
Commission acted swiftly to crack down on allegedly fraudulent activity in this
space, particularly where the misconduct has targeted Main Street
investors. Regardless of the promise of this technology, those who invest
their hard-earned money in opportunities that fall within the scope of the federal
securities laws deserve the full protections afforded under those laws.
Modernizing
Asset Management Regulations
In
June 2018, the Commission proposed for public comment a new rule to replace the
process of individually issued orders for exemptive relief for certain exchange
traded funds (ETFs).[31] The
proposal is designed to create a consistent, transparent and efficient
regulatory framework for ETFs would facilitate greater competition and
innovation among these products. The ETF market, which has a volume
of approximately $3.6 trillion, currently operates under more than 300
individually issued exemptive orders that have varied over time in wording and
terms. I anticipate that the Commission will consider
recommendations to adopt a final ETF rule in the coming year, which will enable
staff to focus more time and attention on novel or unusual ETF products instead
of more routine ETF-related issues.
The
agency is working to promote research in the ETF market and provide investors
greater access to that research. On November 30, 2018, the
Commission adopted rules and amendments that are intended to reduce obstacles
to providing research on investment funds in furtherance of the Fair Access to
Investment Research Act of 2017. The adopted rules seek to harmonize
the treatment of investment fund research with research on other public
companies by establishing a safe harbor for a broker-dealer to publish or
distribute research reports on investment funds under certain
conditions. Overall, these rules aim to promote research on mutual
funds, ETFs, registered closed-end funds, business development companies (BDCs)
and similar covered investment funds and provide investors with greater access
to research to aid them in making investment decisions.
Additionally,
the Small Business Credit Availability Act directs the Commission to revise
certain securities offering and proxy rules in order to harmonize existing
registration and reporting requirements to allow BDCs to be treated in the same
manner as public corporate issuers. The Economic Growth, Regulatory
Relief, and Consumer Protection Act similarly directs the Commission to issue
rules to allow certain registered closed-end funds to use the securities
offering and proxy rules that are available to public corporate
issuers. The Division of Investment Management is working to develop
rule recommendations related to these two bills.
Improving
the Investor Experience
The
Division of Investment Management is leading a long-term project to explore
modernization of the design, delivery and content of fund disclosures and other
information for the benefit of investors. These initiatives are an
important part of how the Commission can serve investors in the 21st
century. Fund disclosures are especially important because millions
of Americans invest in funds to help them reach personal financial goals, such
as saving for retirement and their children’s educations. As of the
end of 2017, over 100 million individuals representing nearly 60 million
households, or 45 percent of U.S. households, owned funds (generally ETFs or
open-ended mutual funds).[32]
In
June 2018, the Commission issued a request for comment on enhancing disclosures
by mutual funds, ETFs and other types of investment companies to improve the
investor experience and to help investors make more informed investment
decisions (Fund Disclosure RFC).[33] The
Fund Disclosure RFC seeks input from retail investors and others on how they
use fund disclosures and how they believe funds can improve disclosures to aid
investment decision-making. In order to facilitate retail investor
engagement and comment on improving fund disclosure, the Commission has
provided a short Feedback Flier on Improving Fund Disclosure, which can be
viewed and submitted at www.sec.gov/tell-us.
The
Commission also adopted a new rule that creates an optional “notice and
access” method for delivering fund shareholder reports.[34] The reforms
include protections for those without internet access or who simply prefer
paper by preserving the ability to continue to receive reports in
paper. Under the rule, a fund may deliver its shareholder reports by
making them publicly accessible on a website, free of charge, and sending
investors a paper notice of each report’s availability by mail. To
inform investors in advance of this new delivery method, there is an extended
transition period so that the earliest a fund could begin to rely on the rule
would be January 1, 2021. During this time, funds that choose to
implement the new delivery method must provide prominent disclosures in
prospectuses and certain other shareholder documents that will generally notify
investors of the upcoming change in delivery format on a recurring basis for a
period of two years.
Security-Based
Swaps and Other Interagency Efforts
With
respect to our security-based swap regime, the Commission has finalized
many, but not all, of the security-based swap rules mandated by Title VII of
the Dodd-Frank Act. In the coming year, I anticipate that the
Commission will continue with our efforts to lay out a coherent package of
rules to finalize our statutory security-based swap rulemaking
obligations.
As
part of this effort, our staff has been actively engaged with our counterparts
at the Commodity Futures Trading Commission (CFTC) to explore ways to further
harmonize our respective security-based swap rules with the swap rules
developed by the CFTC to increase effectiveness and reduce complexity and
costs. I am pleased to note that earlier this year CFTC Chairman
Giancarlo and I executed a memorandum of understanding (MOU) between our two
agencies.[35] The
MOU explicitly acknowledges where we have shared regulatory interests,
including but not limited to Title VII, and reconfirms our commitment to work
together to facilitate efficient markets for the benefit of all market
participants.
In
addition to continued discussions with the CFTC regarding Title VII
harmonization, the Commission and staff has engaged with our fellow financial
regulators to address the key issues in our markets in a holistic, consistent
manner. These efforts will continue, including efforts to simplify, tailor
and make more effective the Volcker Rule, cooperate on innovative issues like
distributed ledger technology and digital assets and address emerging risks to
the financial sector through the Financial Stability Oversight
Council.
Other
Dodd-Frank Act Issues
The
Commission also has several other outstanding mandates from the Dodd-Frank
Act. Earlier this year, I addressed how I plan to prioritize and tackle
these remaining responsibilities.[36] Generally
speaking, in addition to the Title VII regime, there are three categories of
Dodd-Frank Act-mandated rules remaining:
Several
of these, including hedging disclosure and resource extraction disclosure, are
on the Commission’s near-term agenda. Overall, it is the SEC’s
obligation to complete the rules mandated by Congress in Dodd-Frank, and I
intend to do so.
Enforcement and Compliance
Pursuing
Enforcement Matters that are Meaningful to Main Street Investors
The
ongoing efforts made by Enforcement to deter misconduct and punish securities
law violators are critical to safeguarding millions of investors and instilling
confidence in the integrity of our markets. The nature and quality of the SEC’s
enforcement actions during the last year speak volumes to the hard work of the
women and men of the agency. The efforts of the Enforcement staff
over the past year have made our capital markets a safer place for investors to
put their hard-earned money to work.
As noted
by Enforcement’s Co-Directors, Stephanie Avakian and Steven Peikin, in their
Annual Report, our success is best judged both quantitatively and qualitatively
and over various periods of time.[38] Relevant
qualitative factors include, among other things, asking whether we are:
bringing meaningful actions that target the most serious violations, pursuing
individual sanctions in appropriate cases, obtaining punishments that deter
unlawful conduct and returning money to harmed investors. Based on
such an evaluation—and in my opinion by any measure—Enforcement has been
successful. I can assure you that the Division will continue its
vigorous enforcement of the federal securities laws and hold bad actors
accountable, whether on Main Street or Wall Street.
I
would like to highlight the work of four investor-oriented enforcement
initiatives over the past year that show the Enforcement staff’s commitment to
investor protection: (1) the Retail Strategy Task Force, (2) the Cyber Unit,
(3) the Share Class Selection Disclosure Initiative and (4) Enforcement’s work
in returning funds to harmed investors.
In
September 2017, the SEC announced the formation of a Retail Strategy Task Force
(RSTF), which has two primary objectives: (1) to develop
data-driven, analytical strategies for identifying practices in the securities
markets that harm retail investors and generating enforcement matters in these
areas; and (2) to collaborate within and beyond the SEC on retail investor
advocacy and outreach.[39] Each of
these objectives directly impacts the lives of Main Street investors and involves
collaboration between many divisions and offices. We anticipate that
new data-driven approaches will yield significant efficiencies in case
generation and resource allocation by targeting enforcement efforts where the
risks to Main Street investors are the most significant. Although it has
been operative for only a little over a year, the RSTF has already undertaken a
number of lead-generation initiatives built on the use of data analytics (i.e.,
promptly searching for matters to investigate on behalf of retail
investors).
Enforcement
also in September 2017 announced the creation of a Cyber Unit to combat
cyber-related threats. The Cyber Unitfocuses the Division’s
resources and expertise on, among others things, hacking to obtain material,
non-public information, violations involving distributed ledger technology and
cyber intrusions.[40] Together
with the FinHub, discussed above, the resources we have dedicated to the Cyber
Unit’s important work demonstrate the high priority that we continue to place
on cyber-related issues affecting investors and our markets. In its
first year, the Cyber Unit led investigations that resulted in several
emergency actions to stop ongoing alleged frauds against retail investors that
involved ICOs, as well as charges against a bitcoin-denominated platform and
its operator for running an unregistered securities exchange and defrauding
users of that exchange.
Beyond
ICOs and digital assets, the Cyber Unit also led important investigations that
resulted in SEC actions involving alleged cyber-related market manipulations,
account takeovers and other cyber-related trading violations. The
cases brought by the SEC in FY 2018 included charges for allegedly scheming to
manipulate the price of a stock by making a phony regulatory filing and for
allegedly hacking into over 100 online customer brokerage accounts and making
unauthorized trades to manipulate stock prices and profit from the artificial
price movements.
Additionally,
Enforcement expanded its efforts to identify advisers that did not disclose
conflicts as a result of their receipt of compensation in the form of 12b-1
fees. Prior efforts by Enforcement and the Office of Compliance
Inspections and Examinations (OCIE) suggested that many investment
advisers were not disclosing conflicts of interest to their retail customers
relating to the selection of more-expensive mutual fund share classes, which
involved the receipt of 12b-1 fees, when cheaper alternatives were
available. Enforcement announced a Share Class Selection Disclosure
Initiative in February 2018, representing an innovative approach intended to
facilitate the efficient return of money to harmed investors and prompt
remediation of misconduct.[41]
Finally,
in my view, protecting retail investors also means, whenever possible, putting
money back in their pockets when they are harmed by violations of the federal
securities laws. In FY 2017 and FY 2018, the Commission returned $1.07
billion and $794 million to harmed investors, respectively. We remain
committed to this important part of our work, and we expect to continue our
efforts to return funds to victims this year as well.
The
unanimous Supreme Court decision in Kokesh v. SEC, however, has impacted
our ability to return funds fraudulently taken from Main Street
investors. In Kokesh, the Supreme Court found our use of the
disgorgement remedy operated as a penalty, which time-limited the ability of
the Commission to seek disgorgement of ill-gotten gains beyond a five-year statute
of limitations applicable to penalties.
I do
not believe it is productive to debate the merits of
the Kokeshdecision. I agree that statutes of limitation serve
many important functions in our legal system, and certain types of actions as
well as penalties and certain other remedies should have reasonable limitations
periods. Civil and criminal authorities, including the SEC, should
do everything in their power to bring appropriate actions swiftly, and, in our
markets, particularly our public markets, the certainty brought by reasonable
limitations periods has value for investors.
However,
as I look across the scope of our actions, including most notably Ponzi schemes
and affinity frauds, I am troubled by the substantial amount of losses that we
may not be able to recover for retail investors. Said simply, if the
fraud is well-concealed and stretches beyond the five-year limitations period
applicable to penalties, it is likely that we will not have the ability to
recover funds invested by our retail investors more than five years
ago. Allowing clever fraudsters to keep their ill-gotten gains at
the expense of our Main Street investors—particularly those with fewer savings
and more to lose—is inconsistent with basic fairness and undermines the confidence
that our capital markets are fair, efficient and provide Americans with
opportunities for a better future.
I
welcome the opportunity to work with Congress to address this issue to ensure
defrauded retail investors can get their investment dollars back. I
believe that any such authority should be narrowly tailored to that end while
being true to the principles embedded in statutes of limitations.
Protecting
Main Street Investors and Improving Investment Options by Promoting Compliance
Earlier
this year, our OCIE published its 2018 examination priorities, which reflected
a continued focus on the SEC’s commitment to protecting retail investors.[42] In
particular, OCIE has looked closely at products and services offered to retail
investors, the disclosures they receive about those investments and the
financial services professionals who serve them. OCIE has also
focused its attention on several other areas that present heightened risks,
including:
(1)
compliance and risks in critical market infrastructure, such as exchanges and
clearing agencies;
(2)
the continued growth of cryptocurrencies and ICOs;
(3)
cybersecurity; and (4) anti-money laundering programs.
OCIE
conducts risk-based examinations of SEC-registered entities, including
broker-dealers, investment advisers, investment companies, municipal advisors,
national securities exchanges, clearing agencies, transfer agents and FINRA,
among others. During FY 2018, OCIE conducted over 3,150
examinations, an overall increase of 11 percent from FY 2017. This
includes a 17 percent coverage ratio for investment advisers—which increased 13
percent from FY 2017, even as the number of registered investment advisers
increased by approximately 5 percent. OCIE also continued to
leverage data analysis to identify potentially problematic activities and firms
as well as to determine how best to scope the examinations of those activities
and firms.
In
conjunction with our examination activities, OCIE published a number of risk
alerts to inform registered firms and investors of common compliance issues we
observed.[43] This year,
OCIE risk alerts addressed topics ranging from municipal advisor examinations
to fee and expense compliance issues for investment advisers. These alerts
sharpen the identification and correction of potentially deficient practices,
maximize the impact of our examination program and better protect the interests
of Main Street investors.
Enterprise Risk and Cybersecurity
Cybersecurity
at the SEC continues to be a top priority. The SEC and other
agencies are the frequent targets of attempts by threat actors who seek to
penetrate our systems, and some of those actors may be backed by substantial
resources.
Recognizing
the twin realities that electronic data systems are essential to our mission
and no system can ever be entirely safe from a cyber intrusion, it is incumbent
upon us to devote substantial resources and attention to cybersecurity,
including the protection of PII. Over the past year, we have been
focused on a number of areas for improvement, including with respect to IT
governance and oversight, security controls, risk awareness related to
sensitive data, incident response and reliance on legacy systems—and much work
remains to be done.
We are
closely scrutinizing how we can reduce any potential exposure of PII contained
in SEC systems, including EDGAR. In this regard, earlier this year,
the Commission acted to eliminate the collection of social security numbers and
dates of birth on a number of EDGAR forms where we concluded that the
information was not necessary to our mission.[44] Moreover,
return copies of test filings are no longer stored within the EDGAR
system. The staff also continues to explore alternatives to the
current approach, including the possibility of implementing a new electronic
disclosure solution.
The
agency has also focused closely on its cybersecurity risk governance
structure. We now have a Chief Risk Officer who helps coordinate our risk
management efforts across the agency. We have worked to promote a
culture that emphasizes the importance of data security throughout our
divisions and offices. The staff has also been engaging with outside
experts to assess and improve our security controls. For example, on
a technical level, these efforts include the deployment of enhanced security
capabilities, additional penetration testing and code reviews, investment in
new technologies and experienced cybersecurity personnel and acceleration of
the transition of certain legacy information technology systems to modern
platforms. We will also continue to coordinate and partner with both
other federal agencies to identify and mitigate risks to our information
technology environment and assets.
We
also look at cybersecurity from perspectives outside of our internal risk
profile. From an issuer disclosure perspective, it is important that
investors are sufficiently informed about the material cybersecurity risks and
incidents affecting the companies in which they invest. Earlier this
year, the Commission issued interpretive guidance to assist public companies in
preparing these types of disclosures.[45] The
guidance also emphasized the importance of disclosure controls and procedures
that enable public companies to make accurate and timely disclosures about
material cybersecurity events, as well as policies that protect against
corporate insiders trading in advance of company disclosures of material cyber
incidents.
Further,
the guidance expanded on prior staff guidance by addressing the board’s
oversight functions. Existing SEC rules require a company to
disclose the extent of the board’s role in risk oversight. The
guidance noted that this disclosure should specifically include a discussion of
the board’s role in overseeing cybersecurity risk management, to the extent
those risks are material. We are monitoring the market’s response to
our guidance.
From a
market oversight perspective, we continue to prioritize cybersecurity in our
examinations of market participants, including broker-dealers, investment
advisers and critical market infrastructure entities. In assessing
how firms prepare for a cybersecurity threat, safeguard customer information
and detect red flags for potential identity theft, for example, we have focused
on areas including risk governance, access controls, data loss prevention,
vendor management and training, among others. And given the
interconnectedness of our markets, we will continue to work closely with our counterparts
at other federal financial regulatory agencies and the international community
to discuss cybersecurity risks and coordinate potential response
efforts.
From
an enforcement perspective, as previously mentioned, our Cyber Unit is
dedicated to targeting cyber-related misconduct in our markets, including
failures by issuers to make material disclosures.[46] And
finally, from an investor education perspective, our Office of Investor
Education and Advocacy has worked hard to inform investors about cybersecurity
hygiene and red flags of cyber fraud, in order to prevent investors from
becoming victims in the first place.
Increasing Engagement with Investors and Other Market Participants
To
effectively fulfill our responsibility to American investors and markets, it is
essential that the SEC maintain an open line of communication with investors
and other market participants. In FY 2018, the SEC substantially
increased its engagement with an array of market participants to help us
improve our work and better focus our resources and efforts.
Engagement
with Main Street Investors
Over
the past year, SEC staff, my fellow Commissioners and I have engaged directly
with Main Street investors from around the country through town halls, outreach
tours, new digital tools, and other methods.
In a
first-of-its-kind event, on June 13, 2018, the full Commission—all
five Commissioners—and SEC leadership met with more than 400 members
of the public during an investor town hall at the Georgia State University
College of Law in Atlanta, Georgia. This event, organized by the
SEC’s Office of the Investor Advocate and the Atlanta Regional Office, marked
the first time the full Commission met with Main Street investors outside of
Washington, D.C. During the main session of the town hall meeting,
Commissioners provided a range of information to investors and answered
questions from attendees. My fellow Commissioners, other SEC leaders
and I also participated in break-out sessions with smaller groups of investors
to hear their views on specific investor-oriented topics such as combating
fraud. The following day, the agency’s Investor Advisory Committee
hosted a meeting at the same location, providing another opportunity for the
public to engage with the Commission.
This
event kicked off the SEC’s “Tell Us” campaign, which included the additional
roundtable meetings with retail investors I mentioned in Houston, Miami,
Washington, D.C., Philadelphia, Denver, and Baltimore. As mentioned,
to complement these open discussions, the agency also developed a new “Tell Us”
website and feedback flier, specifically designed for Main Street investors to
provide feedback on the proposed disclosures in the standards of conduct
proposals without needing to write a formal letter.
The
SEC also conducted investor research and surveys in FY 2018 in order to better
understand how investors interact with markets. The agency conducted eight
surveys and conducted four rounds of qualitative research involving focus
groups and one-on-one interviews. In addition to these events, day
in and day out the SEC staff engages with individual investors as well as with
investor groups to promote awareness of the SEC’s work and to solicit feedback.
Empowering
Main Street Investors through Information and Education
Across
our seven investor town halls, one common theme—regardless of demographics and
geography—was that investors wished they had known more about investing and our
markets earlier in their lives. This sentiment was universal and
deeply held and, while not entirely within the purview of the Commission to
address, will continue to resonate with me during my tenure at the
Commission.
The
SEC promotes informed investment decision-making through education initiatives
aimed at providing Main Street investors with a better understanding of our
capital markets and the opportunities and risks associated with the array of investment
choices presented to them. Our Office of Investor Education and
Advocacy spearheads these efforts and participation extends throughout our
divisions and offices.
In FY
2018, the SEC conducted over 150 in-person investor education events focused
toward various segments of the population, including senior citizens, military
personnel, younger investors and affinity groups. In addition to
in-person education events, we developed informative, innovative and accessible
educational initiatives.
A
primary focus of our educational efforts is preventing
fraud. Unfortunately, it does not cost much to finance a scam, and it
often is easy for bad actors to reach their targets, particularly over the
internet. If investors know that, as well as some of the hallmarks
of fraud and key questions to ask before they invest or provide personal
information, they are less likely to become victims.
We use
a variety of channels to deliver this message to investors. For
example, we created a website to educate the public about frauds involving ICOs
and just how easy it is for bad actors to engineer this type of fraud—Our
HoweyCoins.com mock website promoted a fictional ICO.[47] The
website was created in-house, very quickly and with few
resources. It attracted over 100,000 people within its first
week. We also published a variety of investor alerts and bulletins
to warn Main Street investors about other possible schemes, including certain
using celebrity endorsements, self-directed individual retirement accounts, the
risks in using credit cards to purchase an investment and the potential harm
resulting from sharing their personal contact information with online
investment promoters.
We
also continued to promote our national public service campaign, “Before You
Invest, Investor.gov”. This initiative encourages investors to
research the background of their investment professional. Our
experience demonstrates that working with unlicensed promoters who have a
history of misconduct greatly increases the risk of fraud and
losses. In May 2018, we supplemented this information service with a
new online search tool, the SEC Action Lookup for Individuals—or SALI.[48] This
tool enables investors to find out if the individual or firm he or she is
dealing with has been sanctioned as a result of SEC action, for both registered
and unregistered individuals. SALI continues to be updated on an ongoing
basis, making it an ever better resource for Main Street investors. We are
encouraged by the fact that unique page views on Investor.gov increased by 45
percent compared to FY 2017.
SEC
regional offices also engaged in investor initiatives in their local
communities. For example, the San Francisco Regional Office has
conducted extensive outreach to California teachers through its Teacher
Investment Outreach Initiative. This project seeks to help teachers
make informed decisions on investment portfolio options, fees and
risk. Regional staff, many of whom have personal connections to the
teaching community, created this initiative in response to learning about the
limitations of the investment options offered to public school teachers under
the defined contribution portion of their retirement plans.
Engagement
with Market Participants
Our
capital markets are far different today than they were a decade
ago. They are increasingly global and highly data
dependent. Investments are channeled through intermediaries and
vehicles, such as mutual funds and ETFs, to a much greater
extent. Our markets also are ever changing and the pace of that
change has increased. It is essential that the SEC understand the
markets of today and continually prepare for and adjust to market
developments. As a result, engagement with those who participate in
our markets extensively, including public and private companies, institutional
investors, broker-dealers and auditors, as well as those who monitor and
oversee markets, including U.S. and foreign authorities, elected officials and academics,
is essential.
In
2018, the SEC held numerous public roundtables at which the Commission and SEC
staff engaged in an open forum with market participants on some of the most
salient issues affecting our markets today.
In
addition to events of this type, the leadership in our divisions and offices,
as well as our dedicated staff, is open to hearing from and meeting with
investors and market participants on areas where our markets are not working as
they should or can be improved—particularly as it relates to our long-term Main
Street investors.
Emerging Market Risks and Trends
I want
to briefly discuss two risks, in addition to cybersecurity risks, we are monitoring
closely: the impact to reporting companies of the United Kingdom’s
exit from the European Union, or “Brexit”; and the transition away from the
London Interbank Offered Rate, or “LIBOR,” as a reference rate for financial
contracts. While these are not the only areas of market risk that
the Commission is monitoring, their impacts are likely significant for American
investors.
Brexit
First,
the potential effects of Brexit on U.S. investors and securities markets, and
on global financial markets more broadly, is a matter of increased focus for me
and many of my colleagues at the SEC. To be direct, I am concerned
that:
To be
clear, these are my personal views, but it is appropriate to share them as they
are reflective of the SEC’s approach to Brexit. The SEC’s
responsibility is primarily related to the effects of Brexit on our capital
markets. For example, I have directed the staff to focus on the
disclosures companies make about Brexit and the functioning of our market
utilities and other infrastructure.
We
have seen a wide range of disclosures, even within the same industry. Some
companies have fairly detailed disclosures about how Brexit may impact them,
while others simply state that Brexit presents a risk. I would like
to see companies providing more robust disclosure about how management is
considering Brexit and the impact it may have on the company and its
operations.
With
regard to market utilities and infrastructure, following the 2016 Brexit vote,
SEC staff commenced discussions with other U.S. financial authorities, with our
U.K. and E.U. counterparts, and with market participants, all with an eye
toward identifying and planning for potential Brexit-related impacts on U.S.
investors and markets. These discussions are ongoing, and I expect
their pace to increase.
Transition
Away from LIBOR
The
second risk that I want to highlight relates to the transition away from LIBOR
as a benchmark reference for short-term interest rates. LIBOR is
used extensively in the U.S. and globally as a benchmark for various commercial
and financial contracts, including interest rate swaps and other derivatives,
as well as floating-rate mortgages and corporate debt. It is likely,
though, that the banks currently reporting information used to set LIBOR will
stop doing so after 2021, when their commitment to reporting information
ends. The Federal Reserve estimates that in the cash and derivatives
markets, there are approximately $200 trillion in notional transactions
referencing U.S Dollar LIBOR and that more than $35 trillion will not mature by
the end of 2021.[51]
The
Alternative Reference Rate Committee (Committee)—a group convened by the
Federal Reserve that includes major market participants, and on which SEC staff
and other regulators participate—has proposed an alternative rate to replace
U.S. Dollar LIBOR—the Secured Overnight Financing Rate, or “SOFR.” The
Committee has identified benefits to using SOFR as an alternative to
LIBOR. For example, SOFR is based on direct observable transactions
and based on a market with very deep liquidity, reflecting overnight Treasury
repurchase agreement transactions with daily volumes regularly in excess of
$700 billion.
A
significant risk for many market participants—whether public companies who have
floating-rate obligations tied to LIBOR, or broker-dealers, investment
companies or investment advisers that have exposure to LIBOR—is how to manage
the transition from LIBOR to a new rate such as SOFR, particularly with respect
to those existing contracts that will still be outstanding at the end of
2021. Accordingly, although this is a risk that we are monitoring with our
colleagues at the Federal Reserve, Treasury Department and other financial
regulators, it is important that market participants plan and act
appropriately.
For
example, if a market participant manages a portfolio of floating rate notes
based on LIBOR, what happens to the interest rates of these instruments if
LIBOR stops being published? What does the documentation
provide? Does fallback language exist and, if it exists, does it
work correctly in such a situation? If not, will consents be needed
to amend the documentation? Consents can be difficult and costly to
obtain, with cost and difficulty generally correlated with
uncertainty.
In the
area of uncertainties, we continue to monitor risks related to the differences
in the structure of SOFR and LIBOR. SOFR is an overnight rate, and
more work needs to be done to develop a SOFR term structure that will
facilitate the transition from term-based LIBOR rates.[52]
To be
clear, a lot of progress has been made to facilitate the transition from LIBOR
to SOFR. We have started to see more SOFR-based debt issuances, and
we have seen promising developments in the SOFR swaps and futures markets.[53] But
I want to make sure that market participants are aware of the need to plan for
this important transition, as a lot of the work will fall on them.
Conclusion
Thank
you for the opportunity to testify today and for the Committee’s continued
support of the SEC, its mission and its people. I look forward to
working with each of you to advance our mission to the benefit of our capital
markets and our Main Street investors.
·
Appendix A
FY 2018 One-Year Agenda (Published in the Fall of 2017)[54]
·
Appendix B
FY 2019 One-Year Agenda (Published in the Spring and Fall of 2018)[59]
(Strikeouts Reflect Completion of Indicated Stage of Rulemaking)
|
|
|
|
|
Appendix C
Footnotes
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4.
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5.
Banks
Accessed N956bn in Q3’18 Through CBN’s Standing Facilities Window to Square Up
Their Positions
6.
Effects
of G20 Financial Reforms On Infrastructure Finance Come Second Relative To
Other Factors
7.
IOSCO
Members Found Mostly Compliant With Principles for Commodity Derivatives
Markets
8.
FSB,
Bodies Publish Final Report on Effects of Reforms on Incentives to Clear OTC
Derivatives
9.
Beginning
Stress Testing’s New Chapter - An Intl’ Perspective On The Future Of Bank
Stress Testing
10. No
Bank Was Referenced By CBN as NOT being Compliant with 30% Minimum Regulatory
Liquidity Ratio
11.
CBN
Reschedules November 2018 MPC Meeting to 21st and 22nd
12. NSE
Proposes Amendments to Dealing Members Rule(s) 7.4 and 7.5
13. NSE
Releases Sustainability Disclosure Guidelines
14. The
Central Bank And The Regulators Of Fintech
15.
SEC
Nigeria Announces The Introduction of The Interpretive Guidance Note
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